The Silver Bear Cafe

There's a big macro theme playing out in Europe – a once soft economic environment that allowed lots of inefficiency is becoming tougher and forcing companies to restructure, says Chris Mayer, author of Capital & Crisis and Mayer's Special Situations.

But the US is harder to navigate right now – there's isn't any 'big theme,' he says.

Chris spent a decade in corporate banking before joining Agora Financial in 2004. Thousands of subscribers now read his stock analysis on a regular basis.

Chris isn't focused on any particular sector – just on finding a small number of opportunities that he believes are worthwhile investments.

I asked Chris for his take on today's macro-economic trends, and whether he was interested in resources and precious metals yet.

Henry Bonner: Looking at the economic environment today, do you think that there's a big macro threat to investors or are you still comfortable investing like normal?

Chris Mayer: That's a great question. I get that a lot because people worry about all these things going on in the world. And there's certainly a long list of things we could be worried about.

But I think of something that Ben Graham used to say, that any individual investor using a variety of approaches ought to be able to find one percent of whatever listed securities are out there that offer attractive buying opportunities. So back in those days, there were something like 3000 stocks in the S&P monthly stock guide and one percent was about 30 securities.

In other words, there are always lots and lots of things to worry about. But for a US investors, for instance, looking at the Wilshire 5000 index (which despite the name only has something like 3,600 names) you ought to be able to find one percent that are attractive. I think that that is profoundly true.

It's kind of like, no matter what the macro environment is, you can always find some things that are interesting.

Henry: And in the current environment, are there specific circumstances that are driving your investments from a macro point of view?

The price of oil has been cut in half and that has had a dramatic effect — not just on oil stocks, and oil-related stocks but also spillover effects in sectors like banking. A number of banks that funded the build-out of the infrastructure for shale oil and gas plays may have some problems.

There's real estate – hotels, for example, that reside in certain remote areas that now may be more questionable. I think this is a giant macro theme and that's one that I talked a lot about in the letters recently.

Another one is, of course, the whole crisis in the EU – the ongoing negotiations between Greece and the Troika and what that will mean for Europe. I mean, Europe is collectively the world's second largest economy.

If you look at it, it's something like 20 percent of the world's trade. It's a very large area and it's a market for US companies.

I've been writing a lot about Europe these last six months. The last year or two, I've been in Ireland, Spain, Greece, Germany, and France. I just came back from Switzerland. I'm very interested in Europe because I think there might be some opportunities there as a lot of those companies are forced to restructure and work their way through a very tough macro environment. So oil and EU I would say are two big dominant trends.

Henry: And you're looking–in the case of the EU– for a recovery in certain assets, correct?

Chris: Yeah, I think there are a number of European conglomerates that in the past have been able to operate very inefficiently, because it has been a softer macro environment. Now it's much tougher and so they are engaged in restructuring. For instance, mergers and acquisition activities are way up in Europe.

Activist campaigns, where shareholders try to pressure management to restructure, are way up too. If you look at spinoffs, something like more than half of the world's spinoffs last year happened in Europe. These companies are reacting to pressures and that's creating some interesting opportunities to do things and buy things – in particular assets that are depressed but that may improve going forward.

Henry: Is there a concern that there's somehow less of a free market in Europe than there is in the US?

Chris: Yeah, I think that has been a traditional worry. It's really hard to fire anybody in France. It's very hard to close factories in Italy and the list goes on.

But I think things are starting to change and if you look at what these individual companies are doing, they are managing to do those things. Look at the change that Marchionne as the CEO of Fiat has implemented there (Marchionne is credited with saving Fiat from collapse1, and is currently involved with turning around US automaker Chrysler2). There's another conglomerate called Finmeccanica in Italy that's undergoing a lot of change, is closing divisions, and selling off things (it recently announced the sale of its rail assets3).

So, on the evidence, I would say that traditionally has been the case. It has been very difficult to do anything in Europe. But I think that is changing.

Henry: Are you also interested in looking at the US right now or are you mostly focused on Europe?

Chris: Most of my focus is actually in the US, and when you look at my newsletters' portfolios, they're dominated by US companies. What's interesting about the US now is that, at least in the past, there has usually been a theme that has been easy to grab on to. So when I started my newsletter in 2004, it was a lot of commodity stuff because that was where the opportunities were.

Then I started to cycle out of that in 2011 and 2012 and started to cycle back into banks and insurance and real estate in the wake of the crisis, and those stocks have performed very, very well for us.

But now I think we're in a market where there isn't a theme like that. I can't just say to you: "Henry, I think you should buy bank stocks" or something.

I think now is the time where we're late in a bull market and most of the opportunities that I'm finding are special situations and quirky opportunities. These include little companies that are engaged in some kind of turnaround — where there's something going on that's different or some sort of catalyst that can unlock value. So it's a kind of a strange market.

To mention some of the most recent stocks I have added, I've got one company that's a little seed company that is really interesting.

I picked up a quirky little LED lighting play that's a turnaround but it's a business that's growing its LED sales by hundreds of percent, quarter over quarter. LED is a more efficient lighting system as you know.

So most of these companies are pretty small — that's the other thing. The US is a very deep market and so there are thousands of securities to look at and some of these are not particularly well-covered. They're undergoing some kind of transition and that creates opportunities for investors to get involved.

Henry: Are there any particular sectors right now that you think might be overbought and that you're choosing to stay away from?

Chris: That's a great question and yes, I think the first sector that comes to mind would be the utilities sector. Utilities have been bid up to very high prices and I think that investors do not appreciate how these businesses have changed. I think investors are just kind of looking backwards and saying, "Well, you're going to get your three or four percent dividend yield and you're going to get a little increase in that every year, so utilities are pretty safe."

I think that those businesses are actually quite dangerous now because there's something going on with the utility sector called "decoupling" where the utilities no longer charge based on how much is used. In other words, there's a decoupling between use and revenue. Regulators are capping how much utilities can make.

Secondly, there's a huge threat from solar. I think people haven't quite grasped how much solar capacity the US is adding. More and more homes have solar energy and don't require electricity from utilities, and are in fact selling it back to utilities.

So if you look at longer-term electricity usage within the US — if you look at the demand from US utilities — it's going to be pretty flat. I think there are a lot of risks in those businesses. You have valuations that are high and you have fundamental changes in the utility business. So, utilities definitely stick out.

The second one I think is pretty easy– it would be anything related to the tech stuff that has gotten way out of hand. Certain companies have gotten really absurd valuations. Look at a company like GoPro, which for a time was trading well above 10 times sales — normally a threshold of absurdity.

Henry: Do you think that those overvaluations are part of an overinflated US stock market or are they really specific to those two sectors?

Chris: I think it's partially because the market is expensive overall. I think it's also driven by the fact that interest rates are so low and investors are really reaching to find yield.

I think that's what has been behind the utility boom. I think MLPs have had a nice run because of that. Real-estate investment trusts (REITs), which also pay out most of their earnings in dividends had a very good run and most of them are very expensive now.

So the more yield-sensitive parts of the market are the ones that seem the most stretched, but then again, if rates stay where they are, they could continue to do well. It's just that at some point, you would think that the environment will change.

Henry: Do you think that, in the current situation, resource stocks are particularly attractive? Are you looking yet at precious metals?

Chris: I am not. I'm kind of a newsletter anomaly that I don't necessarily have an obsession with the yellow metal. To me, it's just another commodity like any other commodity. Commodities have obviously been crushed and I think they're interesting on that basis. A lot of these stocks have just been completely destroyed.

But on the other hand, I am more interested in owning good businesses now and the problem is a lot of these resource companies are very bad businesses. They don't generate cash. They absorb a lot of cash and it's difficult to hold them. I don't feel like I have any particular edge in calling what the price of oil is going to be or what the price of gold is going to be.

So I have a feeling that there are definitely interesting opportunities there. It's just not something I pursue a great deal.

I just started to think about some of the oil companies and I've been fishing around some of the low-cost producers that are able to make good money even at today's oil prices.

So that's kind of interesting and I think there probably are opportunities in gold. One of the things that people may forget is that the oil price is coming way down and that's a nice lift for a lot of gold miners. Energy is a primary cost for gold miners.

Henry: Are you also seeing a lot of companies out there taking advantage of these low interest rates (corporations piled on around $1.4 trillion in debt from 2011 to 2014)?

Chris: Well, I see a lot of companies taking advantage of the low interest rates. I see companies continually refinance different notes they have and so now they're practically getting free money. That's super attractive capital. All these companies are getting five and seven-year money at three and four percent rates. It's hard not to make money with that.

Henry: Thanks for sharing your thoughts on investing with me today Chris. I look forward to talking again.

Ed. Note: Chris Mayer’s our resident investment director. When you subscribe to receive The Daily Reckoning by email (it’s free, by the way) you’ll receive his insights and those of each of our contributors every day the market’s open. Since ’99 we’ve aimed to send the most useful and entertaining fifteen minutes of market commentary and we still do. Click here to join our ranks.

Henry Bonner is an avid student of Austrian economics and is learning the ins and outs of the natural resource business under Rick Rule's apprenticeship. He is reporting on the most valuable lessons and information as the editor of Sprott's Thoughts.

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